Economic schism

1. Say’s Law – “the supply creates its own demand.” (Jean-Baptiste Say, 1803) There are many a starving artist that wish that this were true. “All production is for the purpose of ultimately satisfying a consumer.” (John Maynard Keynes, 1935) Economic schism

2. http://www.youtube.com/watch?v=ZPHSXUS0_1c Positive vs normative Some economists believe that efficiency holds no value, so seeking greater efficiency is positive, not normative. According to the theory of the perfectly competitive market, profits are zero unless a business is able to be more efficient. Record profits to corporations becomes the goal as it shows that the economy is more efficient. Many economists believe that macroeconomics is just an aggregation of microeconomics. The result is a belief that those policies that increase the profits of corporations are good for the economy. Battle of the economic paradigms

3. The Keynesian paradigm was not just about what Keynes had to say. It involved a great many economists who followed the idea that the economy is driven by demand, and that it makes more sense to evaluate economics based on the world as it exists. Washington Consensus is a catch all that includes Classical, Neo-classical, Neo-Keynesian, Monetarist, and other economic theories that believe the economy is driven by the supply-side, and that the economy would behave like the perfectly competitive market if the government wouldn’t keep providing market distortions. Keynesian vswashington consensus

4. The Basic argument • Keynesian • 1932 - 1980 • Economy is demand driven • Consumers as employers • Equitable distribution is necessary for economic stability • Supply side theories lead to cycles of boom and bust • Washington Consensus • Prior to 1932 and after 1980 • Believes supply creates its own demand • Corporations and businesses as employers • There is nothing wrong with inequality • Boom and bust cycles are the result of corrupt governments

5. Demand-side vs supply-side Paint you house Starbucks Artist Who are the job creators?

6. Economic and political stability Economic growth (must at least keep pace with population growth) Low unemployment Low inflation – but absolutely no deflation Normative values Economic equality: Neither paradigm would argue for equality of outcome. The Washington Consensus paradigm would hold that economic inequality is not a problem and that efforts to reduce it are counterproductive and inefficient. The Keynesian paradigm argues that high disparities in income and wealth make the goals above difficult, if not impossible to achieve.

7. Washington Consensus sees the theories of the perfectly competitive market to be natural laws. If the government would stay out of the economy in the manner that they proscribe, the economy will work as predicted in their models. Keynesian economists do not see natural law in the economy. The economy is a set of man-made rules. Those rules can be changed if the outcomes prove to be suboptimal. If the rules are written to prevent the accumulation of capital by the few, and the development of overwhelming market power, then the economy will operate in a closer approximation of the competitive market model. Government and the perfectly competitive market

8. The Keynesian economic paradigm dominated academia and policy decisions from 1932-1980. During this time, equitable income distribution was the primary concern with progressive taxation and strong unions. The Washington Consensus dominated before the Great Depression and from 1980 to the present day. The primary concern of these periods was tax cuts at the highest income levels, easy credit, and free trade. How have we done?

11. “I shall argue that the postulates of the classical theory are applicable to a special case only and not to the general case, the situation which it assumes being a limiting point of the possible positions of equilibrium. Moreover, the characteristics of the special case assumed by the classical theory happen not to be those of the economic society in which we actually live, with the result that its teaching is misleading and disastrous if we attempt to apply it to the facts of experience.” (Keynes, 1935, The General Theory of Employment, Interest, and Money) John Maynard Keynes, 1935

12. “Thus political theory has suffered because it has not taken into account certain economic realities. On the other hand, economic theory has suffered because it has not taken into account the political realities of government decision-making.” (Anthony Downs. 1957. An Economic Theory of Political Action in a Democracy) Downs 1957

13. As Myrdal and Robbins have pointed out in this generation, the individualist-utilitarian creed did, indeed, make the case for free competitive markets and for private property; but it also contained within its presuppositions the case for free elections, on a one-man-one-vote basis; for destroying or controlling monopolies; for social legislation which would set considerations of human welfare off against profit incentives; and, above all, for the progressive income tax. (W.W. Rostow. 1959. The Stages of Economic Growth) http://www.taxfoundation.org/taxdata/show/151.html Rostow 1959

14. “I came to see that there are no economic, sociological, or psychological problems, but just problems, and they are all mixed and composite. In research, the only permissible demarcation is between relevant and irrelevant conditions. The problems are regularly also political and, moreover, must be seen in historical perspective.” (Gunnar Myrdal. 1977. Institutional Economics) Myrdal 1977

15. ”If citizens are unequal in economic resources, so are they likely to be unequal in political resources; and political equality will be impossible to achieve. In the extreme case, a minority of rich will possess so much greater political resources than other citizens that they will control the state, dominate the majority of citizens, and empty the democratic process of all content.” “My aim instead is to describe in very general terms some of the dynamics of equality and inequality, and to assess briefly the play of forces pushing in the two opposing directions in our own time, particularly the forces of democracy and capitalism.” Democracy requires equality while the outcome of laissez-faire capitalism is inequality. Dahl 1985

16. The decisive weakness in neoclassical and neo-Keynesian economics is not the error in the assumptions by which it elides the problem of power. The capacity for erroneous belief is very great, especially where it coincides with convenience. Rather in eliding power--in making economics a nonpolitical subject---neoclassical theory, by the same process, destroys its relation with the real world. (Galbraith, 1973, Power and the Useful Economist) Gailbraith 1973

17. “Power being so comprehensively deployed in a very large part of the total economy, there can no longer, except for reasons of game-playing or more deliberate intellectual evasion, be any separation by economists between economics and politics. When the modern corporation acquires power over markets, power in the community, power over the state, power over belief, it is a political instrument, different in form and degree but not in kind from the state itself. To hold otherwise - to deny the political character of the modern corporation - is not merely to avoid the reality. It is to disguise the reality. The victims of that disguise are those we instruct in error. The beneficiaries are the institutions whose power we so disguise. Let there be no question: Economics, so long as it is thus taught, becomes, however unconsciously, a part of an arrangement by which the citizen or student is kept from seeing how he is, or will be, governed.” (Galbraith, 1973, Power and the Useful Economist) Galbraith 1973

18. Alfred Marshall was the first to be broadly recognized as using mathematical formulas, charts, and graphs to represent, in a shorthand manner, complex economic theories. • “I had a growing feeling in the later years of my work at the subject that a good mathematical theorem dealing with economic hypotheses was very unlikely to be good economics: and I went more and more on the rules – (1) Use mathematics as a shorthand language, rather than as an engine of inquiry. (2) Keep to them till you have done. (3) Translate into English. (4) Then illustrate by examples that are important to real life. (5) Burn the mathematics. (6) If you can’t succeed in 4, burn 3. This last I did often.” (Pigou, Memorials, p. 427) (Ekelund, 346) • Ekelund, Robert, and Robert Hebert. A History of Economic Theory and Method. 5th ed. Long Grove, IL: Waveland Press, Inc., 2007. Print. • What is presented in language is seen as opinion or theory. What is presented in mathematical form is seen as fact. Problem: human behavior cannot be represented mathematically as it varies to such a great degree On economics and the real world

19. Fannie Mae maintained stability in the real estate markets for 40 years until it was privatized in the 1970s. Compare UPS and FedEx to the United States Postal Service. A letter sent to Florida from here will cost you 46 cents. Via FedEx and UPS it will run over $10. Comparisons with packages will show lower rates across the board. Either the USPS is more efficient, or the others are seriously gouging their customers. Particularly when you consider they pay their workers less (salary + benefits). Government as inherently inefficient

20. Does this seem to be effective or efficient health care policy? Which appears inefficient? US as outlier - In statistics, an outlier is an observation that is numerically distant from the rest of the data.

21. Washington Consensus policies have been practiced and taught for the last 30 years. Washington Consensus policies can neither explain our current economic situation nor explain how we get out of it. It is my opinion, based on real world economic data, that five years from now we will have either tanked our economy or returned to Keynesian principles. I have no crystal ball and your future professors may hold with either paradigm, or be open-minded and willing to listen to any argument you can back up with facts. 5 years from now…?

22. Both paradigms utilize the same models. Understanding the models gives us a visual way to understand what is occurring in the economy. A difference is that Keynesians recognize that it is a shorthand used for ease of explanation as opposed to a belief that this is what would happen if the government stayed out of the way. Both paradigms tend to measure economic statistics in the same manner, however, recent years have seen the Bureau of Economic Analysis (BEA) make changes to how GDP deflator is calculated (chain-weighting after 1992). Multiple changes to the calculation of the Consumer Product Index (CPI) have also occured. These changes to how these measures are made have had the result of making GDP growth appear to be higher and inflation lower in comparison to previous measures. Advocates for these changes say that these measures are more accurate, opponents see them as less accurate. We will look at how the government currently calculates these statistics. For the purpose of this class, I will teach the shared terminology, the models, and the measures. The textbook, written by a Professor educated at the Chicago School, and likely a follower of Milton Friedman, will provide the Washington Consensus analysis of the data and models, while I will provide the Keynesian evaluation of the same data. I will be careful to keep contradictory analyses out of exams. How to teach both

23. Washington Consensus: “A number of economists have suggested that this policy change (extending UI to 99 weeks) has resulted in at least 600,000 and perhaps even more than 4 million additional jobless people at any given time.” Keynesian perspective: Extending UI keeps unemployed workers performing their other vital role in the economy as consumers. Preventing more severe economic downturns. Example: unemployment insurance (UI)

24. Supply-side economists argue that unemployed individuals will withhold their supply of labor longer if UI is sufficient to meet minimal needs. As the diagram shows, if there were a greater demand for labor than people willing to work, wage rates would increase. Moral hazard

25. Recession caused by sudden decrease of the demand curve. Businesses cut workforce to adjust to decreased demand. If unemployed workers suddenly have no income, demand would decrease even further, requiring more layoffs, which would decrease demand even further. Typically, 100% of UI immediately goes back into the economy to support demand. Reality of recession

26. Charts to the right show a decrease in demand for workers. Chart below is a reproduction of Figure 7.1 in the textbook. Note the sharp and sudden spikes in unemployment prior to the existence of UI. What does the data show

27. Why such sudden unemployment? Manufacturing jobs had been declining for years. This fact was masked by the boom and subsequent bust of the real estate bubble. The real estate bubble temporarily provided millions of jobs in the construction and financial sectors. When the real estate market collapsed, so did the jobs that the bubble supported. All of this would be inevitable in the Keynesian paradigm.

28. An extended period of deflation can cause the credit markets to freeze. This is why countries that target an inflation rate usually shoot for 1-2% and not 0% Deflation means that the money you have today will buy you more tomorrow. It also means that the money you owe today will be harder to pay off tomorrow. In the Great Depression, the economy was suffering from deflation. The debt the government was taking on was getting harder to pay off. With deflation and banks closing on a regular basis the rational thing for people to do was to stuff their money in their mattresses. Hoarding reached epic proportions and the money supply in circulation was shrinking, further exacerbating the problem. Deflation is a very bad thing

29. Inflation refers to the value of your dollar in the US economy. Exchange rate refers to the value of your dollar in a foreign economy. In the Great Depression, the Federal Reserve Board (FED) followed very strict monetary policy. With the sudden decrease in demand and hoarding the country slipped into a deflationary period. In the current economic malaise, the FED has followed expansionary monetary policy, essentially running a printing press to prevent deflation. The result has been low inflation, but a significant drop in the dollar’s exchange rate. We experienced deflation in 2009, the first time since 1955. For example, 10 years ago something that cost $20 CDN would cost $12 USD. Today, it would cost $20 USD. In the first example it seemed like a reasonable price, now Canadian purchases are much too expensive. Hence all the Canadian cars at Costco and the airport. This also helps to explain manufacturing moving back to the US from Canada. Don’t confuse inflation and exchange rate

30. Some have argued that the rate of inflation is undercalculated by as much as 7% per year. Cost of living adjustments (COLAs) are based on the CPI. You could be losing 7% of real income per year. Newer technologies being added while still monopoly priced. Substitution goods – The price of steak increases, you buy more hamburger, you are not seen as being worse off. Owners’ equivalent rent of primary residence (OER). Missed the inflation of the real estate boom that should have triggered contractionary monetary policy. Some economists (mostly WC types) want to switch to chain-weighted CPI which would reduce the reported rate of inflation by about another .25%. Flaws in the CPI

31. GDP Deflator: chain-weighting reports lower inflation than base year calculations. Makes GDP growth look stronger. Producer Price Index PPI: An advance indicator of future CPI. Personal Consumption Expenditure Index (PCE): Reports overall inflation about .3% under CPI. Provides an argument for chain-weighting CPI. Key things to know about inflation indexes

32. Figure 7.4: We observe the changes to CPI. The textbook discusses deflation as if it is a good thing. It is for creditors and hoarders, the very rich, but bad for everybody else, including the government. Staying out of deflation has been by design. Other than that we see high levels of inflation in wars and oil crises. History of inflation

33. Unanticipated inflation: “creditors lose and debtors gain.” Unanticipated deflation: creditors gain and debtors lose, including the federal government and in turn taxpayers. Who benefits? There is a trade off between unemployment and inflation. If unemployment decreases, inflation typically increases without effective monetary policy. Deflation is a different animal encouraging hoarding, reducing demand and causing severe unemployment.

34. When we talk about recessions and depressions, the primary indicator is usually Gross Domestic Product (GDP). Note that dips in GDP are considered recessions by the FED. Prior to the Keynesian period (1866-1932), the US economy was in recession over 50% of the time. During the Keynesian Era recessions were few, far between and short-lived. http://www.nber.org/cycles.html The business cycle Keynesian theory states that when businesses stop spending then the government should step in and spend to prevent demand from bottoming out. The textbook, by using National Business Activity instead of GDP, hide the effects of government spending on GDP.

35. The textbook states that extending UI to 99 weeks has cost the nation an additional 1.5% in the UE rate. This is the Washington Consensus position even though there is 7 unemployed workers for every job vacancy. Keynesian view: Unemployment and extended UI

36. Depression vs recession Leaving the economy to fix itself, in the Great Depression unemployed people went to food kitchens and slept in tents. Demand plummeted creating more cut backs in employment. Failure to adjust monetary policy led to deflation which encouraged hoarding which further depressed demand.

37. Do regulations cause unemployment?